Next gov’t has task cut out
Greeks will go to cast their ballots on September 16 with the expectation of better days ahead, with the vast majority of businessmen and those active in the market in general hoping elections will produce a strong government capable of introducing badly needed structural economic reforms. Still, the new administration, weak or strong, will have little choice but to take unpopular measures to deal with the deteriorating fiscal situation. According to polls, the ruling New Democracy party is ahead by 0.7 to 2 percentage points over PASOK. Strictly speaking, the difference is within the usual margin of statistical error and therefore the outcome of the elections is uncertain. If, however, other factors are taken into account, such as the advantage of Prime Minister Costas Karamanlis over PASOK leader George Papandreou in terms of popularity, then the lead of the conservatives appears to be more solid. But the prospect of five political parties being represented in the new parliament, coupled with a narrow lead of New Democracy over PASOK, has raised the specter of a weak government. Most economic players do not wish to see this because they think a coalition or a government with a slim majority will be vulnerable and less likely to introduce painful but necessary economic reforms. At any rate, the new government will first have to deal with something more urgent. According to different sources, the fiscal situation, though not precarious, appears to be deteriorating fast. Public finances will definitely be hit and called to bear the additional economic cost of forest fires in certain parts of the country. The government put the initial estimated cost of the natural catastrophe at more than -1.6 billion or 0.6 to 0.8 percent of GDP, saying it may trim Greek GDP growth by 0.3 percentage points. The five prefectures hit worst by the wildfires account for 4.5 percent of GDP according to government officials. Given that tax revenue growth in the ordinary budget lagged behind the 2007 target of more than 7 percent in the January-July period, it is unrealistic to expect a pick up in August-September to close the growth gap. Particularly after the government’s latest relief measures for individuals and businesses in the hardest hit areas for the next six months or more. In other words, the budget target for revenues is unlikely to be met this year and – coupled with expenditure overruns – makes the general government deficit envisaged in the 2007 budget unattainable. It should be noted that Greece was aiming for a budget deficit equal to 2.4 percent of GDP, down from 2.6 percent last year and a revised 7.8 percent of GDP in 2004 following the EU fiscal audit prompted by the conservative government. Nevertheless, claims by Finance Ministry officials that the general government budget deficit will not exceed the threshold of 3 percent of GDP appear to be credible at this point. It will take a sharp slowdown in GDP growth from more than 4 percent in the first half and a protracted breakdown of the State tax collection mechanism in the remaining four months of the year to bring the budget deficit close to 3 percent of GDP or higher. The latter scenario has been observed during periods of political uncertainty and in the first few months after a new party takes power as it puts its own cadres in charge of the tax offices. Suffice it to say that it took a number of months before the tax mechanism started functioning properly after the conservatives came to power in March 2004. Against this background, the first task of the new government will be to address the problem of public finances and ensure that the budget deficit does not deviate significantly from the goal of 2.4 percent of GDP and of course does not surpass the 3 percent mark at any cost. It is not difficult to see how the new government, especially New Democracy’s, will go about controlling this year’s budget deficit and bring it down to 1.8 percent of GDP next year in line with Greece’s updated 2006-2009 Stability and Growth Program. All estimates do not take into account the expected approval of the upward revision of GDP by some 25 percent this fall. Although rhetoric will focus on the need to trim primary budget expenditures, the budget gap will most likely arise from the revenue side. In this respect, the increase in the highest Value Added Tax (VAT) rate to 20 percent from 19 percent is likely. The advantage of this measure is simple. It starts bringing money almost immediately into state coffers. But, it has two disadvantages. First, it increases inflation and secondly it is regressive, that is, it hurts citizens with lower incomes more than the rich and upper middle class. The fact that the German coalition government raised the VAT rate and the conservative French government contemplates a similar move sets an example for ND and perhaps PASOK. It is no coincidence that the conservatives upped the higher VAT rate to 19 percent from 18 percent to secure more revenues in their battle to curb the deficit in the spring of 2005. The move had a minimal one-off impact on consumer price inflation and this provides the new government with an additional argument to counter inflation fears. The increase in excise tax on alcohol and tobacco products is another popular tax raising measure undertaken by successive Greek governments and it is hard to see why it will not be employed again. Another candidate will be car registration taxes. An increase here may be combined with the abolition of a levy on new cars being demanded by the EU. A further measure which may bring in more revenues but is expected to be fought hard by interested parties will be to introduce cash registers at gas pumps. The new government could also bring forward the next two annual increases in the excise tax on gasoline, as Greece is obliged in order to comply with EU rules. In addition, the government will be keen to ensure that revenues from the expected, new unified tax on real estate will exceed those from the various taxes currently being levied. Given the situation regarding public finances, it should be expected that some of the above revenue-enhancing measures will be implemented as early as next month, while the rest will be included in next year’s budget to be unveiled most likely in October. So, whether it is strong or weak, the new government will first have to deal with the deterioration in public finances and secondly with the structural reforms sought by the business community and markets. With elections just two weeks away, the new government will certainly have its work cut out.
